“1,416 miles from the hucksters on Wall Street, one unheard-of “specialty bank” is breaking every rule of modern banking and actually paying its members a fair yield of 7% annually…
“And despite the fact that this has been kept quiet for years now, some of the biggest banks and mutual funds are reaping huge profits from it just for parking their money there. Now it’s time for regular people to get in on the action.”
That’s the lead-in for a recent ad for Tim Plaehn’s Dividend Hunter, which is a low-cost newsletter from Investors Alley that promises to find investments that provide high yields. I haven’t run across this newsletter before, and don’t know anything about Plaehn, but the ad caused me to get a bit of the grumpy face when they started to refer to this 7% yield as if it were a nice, safe bank account or CD… so I thought perhaps we could save a few folks some heartache by explaining what he’s really talking about.
He does everything he can to imply that this special 7% deal is similar to a bank account, here’s a bit more from the ad…
“But what if I told you there’s a virtually unheard of specialty bank currently offering 7%?
“Something like the old days when even just a regular savings account paid you 5%. Even more for CDs.
“It’s not your fault you’ve never heard of this specialty banking firm.
“They don’t advertise. They don’t post their rates online. They don’t take out ads in the local paper or hire washed up B actors for television commercials. And they certainly don’t send out junk mail.”
Sound exciting, right? Like there’s really some secret bank that flies under the radar and pays you 7% interest on your account? Well, no, it’s not a regular old savings product like a savings account or a CD — the last time those sported 7% yields was about 25 years ago, in the very early 1990s.
Man, I feel like I aged about 30 years just by typing that sentence. I remember those yields. Of course, I also remember that inflation in 1990 was well over 5% a year, so those 7% yields were not as sexy then as they would seem to us today, when falling oil prices have pushed the current CPI below 1%.
Here’s some more of the description of the “bank” from the ad:
“A little while back I was trying to find some place to park my money that would give me a decent return. Almost by accident I came across an article about a specialty finance company that was paying members 7%.
“I thought to myself, ‘this is too good to be true, there’s gotta be a catch.’ But like most of us, I was curious and so I kept reading and then digging into this company.
“The more I read, the more I liked them. They were small enough not be on everyone’s radar or featured on every local news station trying to get the scoop on a story about someone finally paying a fair rate of return.
“But large enough to be able to withstand the 2008 financial crisis and offer competitive rates while Wall Street took billions from taxpayers but offered nothing in return.
“And it might sound antiquated or even quaint, but this specialty bank has one simple way of doing business: borrow low, lend high.
“No risky mortgage backed securities, no credit default swaps, no other “innovative” trading strategies or accounting tricks… the kind of shenanigans that got us into the last financial mess.”
So it’s a successful “specialty finance company”, and pays its “members” 7% — and it does so by borrowing low and lending high? We should be able to identify that for you. How about a few more clues?
“… it just recently announced a new type of lending in partnership with another financial institution where it ponies up 20% of the cash but then receives 24% of the profits.”
That sounds pretty good… every little bit helps. More?
“I need to let you know that there is a minimum to get started with this bank. Unlike with most banks where you need to put down $25,000 for their best rates, with this one you can get started with as little as $30.Are you getting our free Daily Update
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“That’s it: just $30 gets you started with them right away.”
There is, of course, no “minimum” to be a “member” of this firm… that’s “copywriter talk” for “this is a stock that costs about $30.” So that’s another clue.
“… they got started up paying out about a year before the 2008 financial crisis really got into full swing. Yet, through it all they never dropped their rates. In fact, they raised them….
“By law, this specialty bank is only allowed to lend to businesses and most of those loans go to mid-size companies: the ones in business long enough to have a good track record and present a low risk of default on their loans.
“They focus on companies in what is called the lower middle market, meaning companies with annual revenues between $10 million and $150 million….
“… our specialty financier partially collateralizes the financing by taking an equity position in the companies it lends to. This is important, because while the investment banks in New York were taking bets against the very companies there were supposed to be helping, in the form of credit default swaps among other complicated trades, our business bank takes a partial position in the company.
“They’ve got skin in the game.”
OK, so that “by law” part means this is almost certainly going to be not a bank, but Business Development Company (BDC) — that’s a tax-advantaged pass-through entity, kind of like a REIT, that was designed into the tax code in order to give smaller, private companies better access to capital. BDCs lend to small and midsize companies, offer some degree of management consulting or assistance to their investee companies, and don’t pay federal taxes on the income they earn from making those loans as long as they pay out at least 90% of that income in the form of dividends to the BDC’s shareholders (like you). These dividends are usually fully taxable income, like REIT dividends, but sometimes they might also include “return of capital” if the BDC is paying out more than what would have been their taxable earnings.
And no, you’re not a “member” or an account holder at a BDC — you’re a shareholder. If the BDC makes money, you get a dividend. If the BDC goes bankrupt, you’re out of luck and your money disappears… and if the economy stumbles and the BDC’s borrowers start defaulting, the BDC could certainly lose value and/or stop paying that dividend. This is really buying a share of stock, not putting money into a high-yield account at a bank.
So… with that said, which BDC is he talking up here?
“Currently the company has just under 200 active clients and $3 billion under management….
“I’m sharing with you one of those firms that came about in the late 1990s. It was a second generation financier and in the nearly 20 years it’s been doing business it’s funded telecoms, manufacturers, importers, software developers, aviation firms, investment advisors, jewelers, logistics companies and much more.
“Like I said earlier, in addition to being diversified across sectors, this specialty financial firm is geographically diversified so they’re not tied to the fortunes, or misfortunes, of any one particular area. They’re financing companies in Idaho, Texas, Pennsylvania, Ohio, Arizona, Indiana, Colorado and just about any place you can think of.
“And all that from one office in America’s heartland.”
OK, quite a few BDCs started up in just the past five years, there was a huge surge of BDC formation as we came out of the financial crisis — so if we’re talking about one that was around before that, we’ve narrowed it down a bit. And we noted at the top that it’s 1,416 miles from Wall Street, and pays out a monthly dividend, and the annual yield is right around 7%… so who is it?
Thinkolator sez we’re being teased about: Main Street Capital (MAIN)
Which is indeed a BDC, and a fairly decent-sized and old one by the standards of the sector — it went public just before the financial crisis, and has a market cap of about $1.6 billion.
The current indicated yield is just under 7%, at about 6.8% with the shares at $32 (only about 10% below the all-time highs back in early 2014, though the stock has mostly been in the $25-30 range for the past two years, reacting strongly to both interest rate and cyclical sentiment). There is also a ETF for BDC stocks that gives you diversified exposure across the segment, called the VanEck Vectors BDC Income ETF (BIZD), and MAIN has strongly outperformed that index over the past five years — up 46%, versus only 3% for the ETF and a weak five-years even for large, strong BDCs like Ares Capital (ARCC, up 22% over five years) and Prospect Capital (up 10%). Those numbers all include dividends, if you ignore the dividends MAIN is one of the few that has seen its share price go up over the past five years.
So it makes sense that MAIN, with above-average performance in the recent past, is priced at a substantial premium to its competitors — in fact, according to BDCInvestor.com, it’s the BDC that carries the biggest premium in the sector, the stock trades at about 1.5X the value of its assets. That’s a lot for a financial company, whose assets are marked to market and carried on the books at something approximating their real value — there isn’t usually anything to companies like this other than their management skill and systems and the loans (and perhaps equity) they own.
And perhaps not surprisingly, it also trades at one of the lowest yields in the BDC arena — given their recent success, investors are willing to take a lower dividend yield from MAIN than they are from ARCC or PNNT or PSEC or most of the other big BDCs. The average yield for BDCs in the BIZD ETF is over 9%, and many of them have yields well into the teens, which is generally a red flag — a sign that investors don’t really believe that yield is sustainable.
This one might be worth some of your research, but do keep in mind that BDCs, like most REITs and other dividend-focused investments, tends to react pretty sharply to interest rate sentiment, at least in the short term. And over the long term, though MAIN has outperformed most income investments over the past five years, the average REIT has done far, far better than the average BDC.
And, yes, since Main Street Capital is headquartered in Houston, TX it is just about 1,400 miles away from Wall Street. Not that this necessarily means anything.
So there you have it… MAIN has been a phenomenally successful BDC investment, particularly compared to the weak performance of most other BDCs over the past five years, and I think it’s being teased by a relatively new newsletter called Dividend Hunter. It’s not going to be like a bank account when it comes to safety (and that dividend is certainly not insured), but it has been steadier than most of its competitors. I’ve thought about BDCs a few times during the past few years, but I’ve never picked a favorite in the sector — If I were to invest in one of these firms, I would probably have taken the easy route and bought the BIZD ETF and seen a pretty tepid performance.
If you feel strongly about BDCs in general, there’s also a levered ETN investment, ticker BDCL, that tries to provide twice the daily returns of the BDC index — over the long term, it has actually performed about the same as the regular old BIZD ETF when it comes to total return (and worse than MAIN or the other stronger BDCs), though with far more volatility… so that might be one to consider if you think BDCs as a group are bottoming out or getting crushed in the short term, like they did back in the January swoon this year, since if the whole sector snaps back (as it just did) the 2X BDCL will snap back faster. Though that requires a talent for market timing (which I don’t usually have) and a pretty strong stomach, buying a levered ETN or ETF just as that sector is getting clobbered.
BDCs are often perceived to have more risk in a rising rate environment than are “blue chip” dividend payers or even REITs, partly because their borrowers might be troubled if the economy weakens… and partly because they often borrow short-term money to lever up, and if you borrow short term and lend longer term your margins can compress as rates rise because the short term borrowing sometimes rolls over to higher rates faster than the longer-term lending. I don’t know what MAIN’s balance sheet is like or what the terms on their loans and investments are, but that’s a general concern some investors have for this group.
Sound like the kind of thing you’d be interested in doing some more research on? You can see MAIN’s SEC filings here, and their latest investor presentation here… if you like or loathe what you see, come back and let us know. I don’t currently have any money invested in any of the BDCs, so I can’t say that I have my finger on the pulse of the industry, and I don’t know a lot about Main Street Capital, but I do have a substantial allocation to REITs and a few other high-yielding investments and I’m not overly worried about the risk of a rising interest rate environment right now.
With that, I’ll leave you to it — use that friendly little comment box below and let us know if you’ve thoughts on MAIN, BDCs, interest rates or whatever else…